Value Investing

Maglan Capital Up +5.11% In April; +19.97% YTD – Details Bullish Madalena Energy Thesis

Maglan Capital increased in value by 5.11% (net of all fees) during the month of April.

For 2015, Maglan Capital has increased 19.97% (net).

In the most recent 3 years, Maglan Capital has averaged an annual gain of 49.09% (net).

Maglan Capital

Maglan Capital – Smaller opportunities with greater Alpha

In the course of vetting investment managers, investors/allocators unanimously ask for a manager’s “edge” or, hopefully for the manager, “edges.” One of our edges at Maglan is our relative size and the resulting availability to focus on smaller investment opportunities (i.e. < $1B EV). Many times, the modest size of an investment naturally leads to a lack of research analyst coverage and a lack of institutional investors, leaving more opportunity for an investor like Maglan. Furthermore, sometimes a smaller investment is analogous to a larger peer, only with a much greater upside) differentiating them, in favor of the smaller investment.

In addition to the greater gain potential, many of the foregoing factors allow us to reduce position-level risk by conducting due-diligence that other investors in the relatively small opportunity haven’t or can’t conduct, and thereby we can increase our conviction. Moreover, to the extent that we find a need to actively urge the company’s Board to adopt certain strategies or carry-out certain activities, our experience and sophistication as investors, bankers and attorneys in higher profile, more complex situations, lends credence and support to our efforts.

Argentina’s energy sector is poised to benefit from enormous investment and development, resulting in catapulting values. Investors seeking large companies with such exposure can focus on YPF, the state-controlled energy firm, and other energy multi-nationals (e.g. Chevron, Exxon Mobil, Total, Petrobras) that have substantial exploration and production (“E&P”) presence in Argentina; although, the benefit will be diluted within the multi-nationals. In the case that those larger investment targets prove successful, Maglan’s investment in Madalena Energy, a much smaller, Argentina-centric oil and gas E&P firm, will prove to be a blockbuster. Moreover, in the case of Madalena, we’ve had the benefit of installing 2 current members of the Board of Directors, including the Chairman of the Board.

Maglan Capital – Madalena Energy (MVN; MDLNF)

Our Trip to Argentina

In late April, we traveled to Argentina with other investors and sell-side analysts to meet with Madalena’s leadership (Chairman, CEO, Argentina Country Manager, and Head of Engineering) and to visit one of the company’s primary oil fields (in Puesto Morales) and the site of the company’s most recent well; a 12-stage frack, the most complex in Argentina’s history, which is expected to yield over 300,000 barrels for the life of the well, with great economics (~$5mm drilling costs, currently fixed $77/barrel oil price, yielding ~$15mm net-profit for the life of the well).

While in Argentina, we also met with Argentine economists and political analysts regarding the economic outlook and the upcoming presidential election. Lastly, we met with management of a few of Madalena’s peers, including, YPF, Andes Energia (AEN) and Americas Petrogas (BOE).

In short, over the past year, Madalena’s focus has been refined toward its most valuable and profitable opportunities in Argentina. Madalena’s conventional oil and gas production has increased and will continue to increase materially, and its unconventional assets will become proven. Throughout, the company is being perfectly positioned to seize maximum advantage of the increased interest in Argentina’s energy industry that will come with the change in political and economic climate.

We continue to be excited by the investment, which gained >10% in value in April, with an expectation that over the long-term, the investment could yield a 6x+ return.

A summary of our evaluation of Madalena is:

  • Asset rich (acreage, proved reserves, production facilities, low commitments, cash, no debt)
  • Operational excellence and strength (existing and growing conventional production; fracking expertise (in stark contrast to peers), burgeoning unconventional exploration and production; good union relationships, excellent domestic management)
  • Clear strategy and vision from a strong leadership team (paramount concern for shareholder value and return on capital, identifying and divesting non-core operations, focused on valuable solutions to increase liquidity for increased E&P activity)

Currently, the company’s most significant issue (a good one) is that it’s being confronted by more drilling opportunities than it can immediately finance. Madalena’s leadership is keenly aware of that primary issue and is focused on:

  • developing its conventional oil fields (Puesto Morales, Surubi) with horizontal drilling to drive production growth and cash flow. Capital requirements for the program are expected to be supported by liquidity from a new credit-facility and sale of non-core assets;
  • deploying excess cash-flow to de-risk and prove Madalena’s massive shale assets; and
  • exploiting the enormous value of the shale assets strategically by entering into joint venture relationships with strategic partners.

Maglan Capital – Argentina Political and Economic Outlook

We critically appreciate the additional layer of political and economic risk that could affect our investment in Madalena. In response to the additional risk, we demand a higher return profile than we do otherwise from our core investments. In addition, we remain zealously aware of the political and economic landscape, particularly as it relates to energy, oil and gas policy.

Argentina is technically in-default on its sovereign debt, is suffering from >15% inflation rate, has a stagnating or even shrinking economy, and has a debilitating exchange-rate regime. The next Presidential administration must confront and resolve the technical default and relax capital controls. Although the foregoing symptoms seem varied, the common, principal cause is singular- energy subsidies- which can reasonably be fixed.

Argentina needs sustainable energy supply for dependable growth and to increase its dollar reserves. All the leading Presidential candidates want to create an immediate flow of capital to energy development. Argentina needs the development, particularly in the Vaca Muerta, to increase production and to avoid using dollars to purchase oil and gas abroad. Becoming a net exporter of energy is necessary to balance the flow of capital back into the country.

Our view on Argentina’s politics and economy includes:

  • the Government and the population have been historically and are currently pro-development of the oil and gas sector; Argentina must return to being a net exporter of oil and gas (it has been a net importer since 2010);
  • all current Presidential candidates are politically Right from the existing administration, and are expected to adopt more business-friendly policies; and
  • the differences between the Presidential candidates will manifest in how quickly positive macro catalysts unfold.

Energy in Argentina and the Shale

Argentina is currently a net importer of energy, despite sufficient oil and gas reserves to become a net exporter. Oil and gas are two of Argentina’s most predominant natural resources. Until 2011, when the Vaca Muerta unconventional, shale play was in its infancy, Argentina’s oil and gas production came entirely from conventional (non-shale) plays. Currently, oil prices are set by the government at $77/barrel, with $3/barrel incentives for increased production. Further, natural gas in Argentina is fixed by the Government at $4-$5.50/MMBTU,1 with an incentive program for new gas at $7.50/MMBTU. Conversely, Argentina is currently importing a substantial amount of natural gas at an average price of $16/MMBTU.

The Vaca Muerta is the next unconventional (shale) oil and gas field in the world to be developed. The Vaca Muerta is estimated to hold the 4th largest recoverable deposit of shale oil in the world behind Russia, USA and China and the 2nd largest recoverable deposit of shale gas behind China. The shale formation is exponentially larger than the Bakken and Eagle Ford shale plays in the United States.

Madalena is the only junior company with acreage in the sweet-spot of the oil window of one of the world’s hottest unconventional shale plays and the only shale play outside of North America that is moving to development. Madalena’s net 132,000 acres in the Vaca Muerta will become more and more valuable as Madalena continues drilling and proving its reserves, and as the large industry players continue to invest in development there. Since 2010, the Vaca Muerta has been the focus of >$4B of investment from major oil companies; $2.2B has been dedicated within the last 12 months alone.2 Recent transactions in the Vaca Muerta have valued drilling rights at $5,000 to $17,000 per acre ($660mm to $2.2B for Madalena’s net acreage; Madalena’s entire market capitalization is currently less than $200mm).

Madalena’s Conventional Oil and Gas Production

Apart from the massive Vaca Muerta shale value, which Madalena is working to de-risk, Madalena has vast upside value in its conventional oil plays, which are currently in increasingly efficient and robust production, and which could be expanded exponentially.

One year ago, Madalena had 3 drilling concessions in Argentina and production of less than a 1,000 boe/d3 in Argentina. Presently, the company has 13 concessions and production of 3,600 boe/d in Argentina, which yield on average $32+ net cash-flow/barrel (“netback”).4 No other energy E&P company anywhere in the Americas is generating $30+ netback on average in the current environment. Moreover, the netbacks will grow with scale and efficiency. This is critical because it allows Madalena to reinvest its cash-flow, equal to a quarter of its market capitalization, into growing its exploration and production. With oil and gas prices fixed in Argentina, currently at USD $77/BBL and USD $4-$5.50/MMBTU (plus incremental production incentives), Madalena is insulated from volatile world-pricing and is able to profitably drill and increase production.

Madalena’s conventional production is currently focused on 2 fields- Puesto Morales (100% working interest (“WI”)) and Surubi (85% WI).

  • Puesto Morales was purchased from Gran Tierra Energy (GTE) in 2014. In the purchase ($63mm price), Madalena received 11 blocks in northern Argentina and the Puesto Morales oil field and treatment plant (picture above). The Puesto Morales plant is North American-quality; it has 12,000 boe/d capacity and would cost >$40mm to construct today. Currently, the plant is processing ~1,700 boe/d and has a lot of remaining capacity.
    • In March, Madalena drilled a 12-stage horizontal well at Puesto Morales (picture below). The well is the most complex and efficient well in Argentina’s history, and will surely command the attention of oil majors looking for opportunities in Argentina. 5 Once normalized, the well is expected to produce ~400 boe/d.
    • Puesto Morales is going to become a cash flow engine. In Puesto Morales, Madalena has the ability to drill ~100 horizontal wells. Well costs are $4-5mm per well. The expected earn-back is approximately 1 year, with ~$15mm of profit over the life of the well. Based on the foregoing, Madalena is striving toward having a dedicated rig on-hand in Puesto Morales to drill one well per month.
  • Surubi is located in Northern Argentina and was also purchased from Gran Tierra. Currently, Surubi (conventional) is producing 1,000+ boe/d and has netbacks of $56/BBL. Surubi is a cash-cow. Surubi has considerable inventory for additional wells too.

With additional capital, Madalena could explode the capacity at Puesto Morales and Surubi. We believe the company can become a 10,000+ boe/d producer in the intermediate term which will allow it to substantially and quickly invest in de-risking its shale assets. The key is properly financing the conventional development program.

Explosive Growth in Conventional Production with Liquidity from operations, cash, debt financing, sale of non-core assets and joint-ventures

In contrast to many E&P companies that are hobbled by large debt-loads and/or by crippling state-imposed drilling obligations (“commitments”), Madalena currently has NO debt, enjoys a meaningful cash balance and has minimal commitments, which leads to robust free-cash-flow before growth capital expenditures.

Management’s plan is to drill the daylights out of the most fertile and profitable plays in Puesto Morales and Surubi. In order to maximize the opportunity, the company is focused on raising liquidity by (i) securing an asset-based credit facility of up to $50mm; (ii) divesting non-core assets, such as, Madalena’s Canadian operations and some blocks in the Northern Argentina, adjacent to the Surubi block; and (iii) entering into strategic joint-ventures. On the JV front, now that Madalena has executed on the country’s most complex and efficient well, it is a formidable partner for a co-venturer.

Madalena’s Shale (Unconventional) Development

With regard to its shale plays, Madalena is most imminently focused on its interests in the Curamhuele block (90% WI) and the Coiron Amargo block (35% WI). In Curamhuele, the company will drill 2 horizontal wells beginning this summer. One well, in the Lower Agrio (oil focused), will be drilled and immediately brought on production. The second well will be in the Mulichinco (liquids-rich gas bearing tight sand play), which will also be drilled, but a pipeline will be needed to be built to bring production to market, which will be completed in the 4th quarter. In Coiron Amargo, in the 4th quarter, drilling will occur on an existing well and a new well, with expectations of ~300 boe/d for each well.

Through 2015, Madalena is well positioned and staffed to de-risk its shale assets. Once de-risked, since there are multi-billion dollar E&P programs surrounding and immediately adjacent to Madalena’s blocks, Madalena will be in a position of strength to consider divesting its assets and/or further developing those assets in joint-venture structures.

Madalena’s Leadership and Operational Excellence

Since Maglan’s active involvement in Madalena, the company’s leadership has defined a clear strategy and vision.

On the ground, the company has organized a class-A team with deep engineering, production, exploration and drilling experience. The company has imported from Canada horizontal drilling know-how; the Puesto Morales 12-stage frack is a great example of that value. Experience, expertise and diligence will lead to more successful wells and more efficiency in drilling, which will greatly impact profitability; successful fracking can result in fewer wells being drilled, each with more fracks. The company has solid relations with its union employees in Argentina; in fact, during the 12-stage frack, the union employees voluntarily worked around-the-clock. The biggest competitor, YPF, has costly and inefficient wells and, by its own admission, it has no choice but to focus on horizontal drilling.6 It is estimated that YPF’s horizontal wells generate a sub-10% IRR; Madalena could get well above 20%. YPF has limited knowledge and expertise related to fracking. Madalena’s local competitors (BOE, AEN) lack liquidity and production to fund their commitments.


Madalena’s current market-value (<$0.40/share; <$200mm EV) does not fully account even for the company’s conventional assets or its reserves. Madalena’s net asset value is approximately $0.60/share based on conventional resources, with little to no value assigned to the high impact unconventional shale resource potential. We believe Puesto Morales and Surubi can be developed into a real production play and can be worth more than $1.50/share. In addition, the company has net shale acreage which can be worth between $660mm and $2.2B ($1.25/share to $4.00/share). Ultimately, we expect that within 2 years, the stock will be worth over $2/share and yield a 6x+ return on investment.

Co-Investment Opportunities

In select situations, Maglan offers its investors an opportunity to co-invest on a reduced fee basis. Currently, we are offering the opportunity to co-invest in Madalena Energy. Previously, Maglan’s investors have benefited from amazing gains on co-investments in MGM Studios (MGMB) and FairPoint Communications (FRP); in each instance, investors’ investment increased over 200% in under 2 years. We expect similar results from Madalena.

Maglan Capital is an event-driven investment fund with a concentrated portfolio of investments across the capital structure of small- and mid-cap companies with core focus on financial distress, restructuring and operational turnaround.

We appreciate your support and confidence in our team.

Best regards,

Steven Azarbad, Chief Investment Officer and David D. Tawil, President

1 “One Million British Thermal Units”

2 In 2015, Vaca Muerta began its fifth year of production. In January 2015, Vaca Muerta produced 38,464 boe, which is eight times more than two years ago, when 4,775 boe was produced. The Government of Argentina estimates that 700 wells are planned to be drilled this year in the Neuquén Basin (the basin in which Vaca Muerta is located); half will be unconventional-focused.

The majors (e.g. YPF, Chevron, ExxonMobil, Petronas, Petrobras, Gazprom) are investing billions in Vaca Muerta exploration and production, in blocks located immediately adjacent to Madalena’s fields. Some majors already have an operating presence in the Vaca Muerta (YPF, Chevron, Exxon Mobil), others only have financial interests and are actively looking for an operational presence. Most recently, in August, in the midst of the oil crisis, Chevron voluntarily restated its commitment to investment in the Vaca Muerta, to achieve production of “3.1mm boe/d by 2017”. The more drilling heats up, the more attractive Madalena’s acreage becomes.

3 “Barrels of Oil Equivalent Per Day”

4 In the Surubi block in the Noroeste Basin, Madalena’s production (+1,000 boe/d) yields $56 netback.

5 A great video of the preparation for and execution of the well is available at:

6 Currently, the average well in Argentina produces 60 boe/d. In that light, the efficiency of and productivity from horizontal drilling is staggering.